Guest Interview:

Uniplan Investment Counsel

22939 West Overson Road
Union Grove,WI 53182

Interview Quarter: 3Q1994

Richard Imperiale

President

Q: Richard, tell us what kinds of portfolio services you offer.

A: Imperiale Uniplan offers a unique quantitative balanced investment product. Our goal is to achieve consistent growth of capital in good market environments while protecting capital in adverse markets. We have been using this same disciplined approach since the firm was founded in 1984. After reviewing your brochure, I'd say your approach is certainly original.

Q: Would you tell us a little about your quantitative modelling process?

A: Imperiale Our approach screens company data through a rigorous proprietary modelling system. The objective is to identify companies which have the critical elements in place to be recognized by the market as quality investment candidates. Our methodology captures the relationships between key statistical elements of company data and isolates those companies which the greater market will recognize as worthy investment candidates.

Q: You say you select companies - don't you pick stocks?

A: Imperiale Yes, we pick stocks, but we also buy bonds. So, first we pick companies that pass our quantitative modelling process. Once we have target companies we then decide, through a risk adjusted valuation process, if we would rather own the stocks or the bonds of those companies.

Q: Can you explain a little bit more about how that stock/bond decision works?

A: Imperiale We like to tell clients that we put on our Buyer and Banker hats and try to decide if we would rather own the company itself, like a buyer, or loan money to the company, like a banker. We do this by placing a valuation on the company like an appraiser would value a private company and then we compare that value to the current market value of the company. If we decide the company is worth more than the current market price we would want to own the company. But, if the company appears fully valued we don't give up on the idea of investing in that company - after all, the company has made it through a rigorous, quality screening process. So we look at the debt side of the company for investment possibilities if we think it's to expensive to own on an equity basis.

Q: How does this buy-or-lend review process affect the number of stocks and bonds you own at any given time?

A: Imperiale The process determines how we construct our portfolios which in turn drives our asset allocation process. Let me explain. We view a portfolio as thirty to thirty-five investments. Each investment could be in either a stock, or a bond, or cash. Our first objective is to fill the portfolio with stocks because we know over the long term stocks will provide the best total return for our clients. But, there are often times when we can't find enough candidates to own 35 stocks because the companies that come out of our models are fully valued based on our analysis.

Q: So then you look at the bonds of those companies?

A: Imperiale Yes, once we have made all the equity investments we find attractive, if we still have slots remaining in the portfolio, we review the debt opportunities of each of the remaining companies. We like to buy the debt issue of a candidate company if it's available at a spread to the government bond which is greater than its historical average spread. This would indicate to us that the bonds were a good value based on their trading history.

Q: And, if you can't find enough bonds?

A: Imperiale If we can't find enough bonds then we hold cash until we find more stocks or bonds to buy. This methodology determines our portfolio allocation which gradually changes over time. This chart represents our historical allocation by quarter over the last 10 years. Our allocation changes occur slowly over time. Because our methodology uses the long term government bond yield as a starting point for our discount models, we tend to migrate from one asset class to another as the available "cheap" candidates among stocks and bonds diminish due to high general valuation levels in any given market.

Q: Do you place any limits on your asset class allocation decision?

A: Imperiale No. In theory we could own a portfolio of 100% stocks, bonds or cash. Historically we have been as high as 80% in stocks, 70% in bonds and 50% in cash. But on average we are 50% stocks, 45% bonds and 5% cash. That's about standard for a balanced manager. But, if a particular client has reasonable allocation limits, we can normally work within those guidelines. It appears as if you look at a vast amount of data when you run your screening process.

Q: How does that process work?

A: Imperiale We start with a universe of approximately 2600 companies in our database. We have a profile of 100 data items about each company which we collect each month. This company data profile spans five to ten years for each company. This data is used in our basic screening models which we run each month.

Q: What type of companies compose the universe? Big cap? Small cap?

A: Imperiale The universe is a designed to be a representative sample of the U.S. public equity markets. We have all the S&P 500 and all the component companies of the Dow Jones Indices as well as 1500 of Value Line's universe. We include big and small cap issues. All 88 Standard and Poor's industry groups are represented. We also track 130 ADR's of foreign corporations.

Q: Once you have all this data assembled, what are you looking for?

A: Imperiale We screen the data and score the companies in each of three categories: fundamental, risk adjusted earnings and quantitative technical. A company must be in the top 10% of each of these categories to successfully pass our screening process.

Q: Why did you decide to score companies in each of those three areas?

A: Imperiale When we decided to build our selection system, we asked the question: What investment styles drive the market? We decided that there were three major style modes which drive the value of a company. First there was value investing as described by Graham and Dodd; these elements make up the fundamental portion of our model. Then we isolated growth and earnings aspects of company valuation and developed the second leg of our screening model. Finally, we examined technical and quantitative styles and used those concepts to develop the final portion of our model. We decided it was difficult to determine which style was in favor at any given time. We also knew that each style seemed to come in and out of favor periodically. But we did discover that when companies have strong elements of each style, they tend to do well no matter which style is in or out of favor. I like to think we took the best bits and pieces of many investment methods and adapted them to work together.

Q: This seems to be a very comprehensive method of analysis. Is it static or do you make adjustments to it?

A: Imperiale The model is not static. Dynamic systems, like markets, change over time and we make adjustments to capture those evolutions. Each year we run a regression analysis that measures the covariance of dependent variables and tests for changes in these relationships. The answers we obtain from that analysis allows us to change the weighting we place on each element of our model. We find that the importance of elements emerge over several years and then diminish in very much the same way they emerged.

Q: Can you give us some examples of those changes in your models?

A: Imperiale Sure. In the early 1980's we observed that cash flow began to emerge as a dominant element. As we arrived in the mid 1980's cash flow subsided to a more normal weight and low deviation earnings growth emerged as an important factor, particularly among larger capitalization companies. In the late 1980's top line growth along with margin expansion were very important elements. In the early 1990's we observed a return to normalized earnings to be a very important factor, particularly with high deviation of earnings companies. Now, positive earnings surprises seem to be very important in the current market environment.

Q: So your model screens for companies that have characteristics which are currently attractive to investors. But when you are wearing your buyers hat, how do you value a company?

A: Imperiale As I mentioned earlier, we use a risk adjusted valuation method when we are considering buying a company. If a company passes our screening process we put a dollar value on that company. To do this we use an earnings discount model that measures the rate of growth of a company's long term historical earnings against the rate of change in it's near term quarterly earnings trends. This allows us to produce a next-quarter earnings estimate and a earnings growth number. With that in hand we calculate a risk premia for the company based on its historic standard deviation of earnings and the current long government bond yield. That's all we need to put a value on the company. Once we value the company, we divide the market value into the company value to arrive at a price-to-value ratio. We find that when a company is selling at a market price of less than 80% of its discounted value it is a strong equity candidate. If it has a price-to-value ratio of more than 120% then it would become a debt investment candidate because we would conclude that the market had fully recognized the equity value of the company.

Q: Are the systems you use hard-wired or do you allow for some degree of human judgment?

A: Imperiale Our investment process is not a black box. Once we have screened down to a list of companies for potential investment we submit them to intense subjective analysis. We read the company's annual report and review the 10K and 10Q's. We also like to review the current Wall Street research on the company and talk to the management as well as their customers and competitors. From a subjective viewpoint we like to see an underlying story emerge as we review a company. For example, new management or a new business focus or successful new products might indicate a new underlying theme for investment. Add happy customers and envious competitors and the mix begins to take shape. If the company is under-covered by analysts and insiders are buying shares those would also be positive subjective indicators. So, even though we have a candidate company for investment, we often eliminate the company after a critical subjective review shows no that the company has no real underlying investment theme.

Q: If you think the company is too expensive from an equity standpoint, how do you evaluate it as a lender?

A: Imperiale The nice aspect of our fundamental screening is that it delivers to us a complete credit profile of the company. It compares key credit elements of the company to those same elements of its industry group peers. It also scores key trends on the company's balance sheet and income statement such as margin expansion and asset turnover. So the credits we look at are usually the best among their peers. And, even if the stock market has fully valued the company, we have noticed that the bond market is much slower to react by revaluing quality companies. The bond market tends to take its valuation lead from the credit rating agencies and they certainly don't make snap credit judgements. As we mentioned earlier, we examine the debt of the company and how it has traded on a spread basis to like treasuries. If we can buy it at wider than its historical norm we are likely buyers. Our debt style would probably be characterized as credit anticipation. Forty percent of the bonds which we have owned were upgraded by a credit agency while we held them. This really helps the return profile of our debt component even when the bond market environment as a whole is less than favorable.

Q: Do you have any industry or position limits?

A: Imperiale When an broad industry group appears to be a buy, we will normally limit our total exposure to twice the group's market weighting. With regard to a single company, we generally buy a position which is 2% to 3% of the total portfolio value in size. If the position grows to twice its initial size, we will reduce our exposure back to the original position size. We like to hang on to the winners, but we don't want them to become too large a portion of the total portfolio.

Q: With such a disciplined approach to selecting securities do you have a method to decide when to sell a company?

A: Imperiale Yes, we have a pretty straightforward sell discipline. If a company we own fails to pass any one of the three screening legs of our model it becomes a candidate for sale. The company is marked to the market at the time it fails to screen. If it violates that "marked price" it is sold. If it continues to appreciate, the marked price is adjusted upward and when it eventually violates that revised price it is sold.

Q: Richard, I know you were the primary developer of this system. Could you please give us some information about your professional background?

A: Imperiale I went to college at Marquette University where I studied finance. My first job out of school was as a credit analyst at a large bank. It was there where I learned the concept of credit scoring and the statistical measure of risk. I scored corporate credit applications and those that passed were sent on to a senior analyst for subjective evaluation. It was not my idea of a career, but I learned a lot about credit and risk. After that, I went on to a brokerage firm where I was part of a group that developed a hedged municipal bond product. This was long before muni bond futures, and part of my job was to determine how this portfolio could be hedged using treasury futures. It was then when I learned how to use many of the statistical tools which are employed in our current investment approach.

Q: How did you decide to form your own firm?

A: Imperiale While I was in the brokerage business, I noticed a large market segment that seemed neglected. Closely held companies with ERISA plans in the $1.0 million to $10.0 million range were not being served. They were too large and sophisticated for the entrepenurial owner/manager to be pleased with mutual funds but these plans were generally too small to be of interest to most investment management consulting firms. The plans were normally at either a bank trust company or an insurance company. Neither seemed to produce results that satisfied the client. The company owners tended to represent most of the dollars in these plans. They wanted complete and diversified investment management, but they also wanted active risk management. I attempted to develop a turnkey approach that would address the specific needs of that market segment. Good up market performance with lower total volatility was the goal.

Q: Is that the type of client that is happiest with your investment style?

A: Imperiale That type of client tends to make up a large percentage of our client base. But our style has also been employed by larger plan sponsors as well. It seems we blend well from a total risk perspective with other more volatile specialty managers. This has led some consultants to use us as a core manager with other higher volatility equity managers. We have also been chosen as the balanced option on some 401(k) plans.

Q: Who are the other principals in your firm?

A: Imperiale On the portfolio side there are Dan Ringsred and Lou Chambers. Dan ran a $600 million common and collective portfolio group for a large bank trust company. His portfolio style was also quantitative and he did extensive work with asset allocation modelling. Dan studied economics at Dartmouth. Lou was the chief investment officer at a bank trust company before running his own investment management firm. Lou is a member of the investment management committee and oversees Uniplan's marketing efforts. Lou studied economics at SUNY -Buffalo. Jeff Decora is also a shareholder at Uniplan. He is our chief compliance officer and handles all aspects of Federal and State securities reporting. Jeff has a law degree from Harvard College. Prior to joining Uniplan, Jeff was in private practice.

Q: What is your present size and what are your plans for the future?

A: Imperiale We are currently about $220 million in assets. We have been in a controlled growth mode with an objective to expand to $500 million in assets by the end of 1996. There is no practical limit to the level of gross assets we could manage based on our style. It's our feeling that Uniplan could comfortably manage $1.0 billion with our current portfolio team and staff infrastructure, but our objective of $500 million should allow us to maintain a high level of customer service while providing quality investment management.